Private lending in China gives cash-starved small and medium-size enterprises (SMEs) much-needed financial support that state-owned banks can’t possibly provide, according to Royal Bank of Scotland.
“Underground market lending serves a very meaningful purpose [for SMEs],” said Wendy Liu, head of China research at RBS. “Although the interest rates at private lenders can be up to four times higher than the benchmark rate, the administrative costs are only a fraction of those for official banks. They don’t need to take people out dining or send gifts [a common practice when applying for loans from state lenders], so they save other costs and the SMEs don’t borrow that much anyway; then the costs work out okay. Many SMEs think [the private lenders] are good and efficient.”
Informal lending is hardly new in China — the country’s SMEs, which contribute 60% of the economy, have long struggled to get access to credit, giving rise to a boom in underground lending. However, concerns have grown since Beijing started to tighten credit in 2010, after a massive credit expansion in 2008 and 2009.
Estimates of the size of the market vary greatly as there is little agreement in what constitutes informal lending. Credit Suisse estimates it is worth Rmb4 trillion ($625 billion) and is growing at an annual rate of about 50%, with many of the loans going to the property sector. Other banks reckon the market is even bigger. According to UBS, total outstanding off-balance-sheet credit stands at roughly Rmb12 trillion ($1.88 trillion).
Media reports abound of problems arising from underground lending in Wenzhou, in eastern China’s Zhejiang province, where private businesses are particularly vibrant. Global banks have also issued reports warning that underground lending has grown to a scale that poses a serious risk to China’s financial markets.
“Every year people lose money because of [informal lending], but they don’t protest to the government,” said Liu. “It’s an area of the economy that the current official system can’t serve.”
Indeed, even when the state was flooding the official banking system with easy money, Chinese banks’ loan books were not opened to SMEs — with most of the money going to state-owned borrowers or firms with strong government ties. Official lenders counter by complaining that few SMEs offer good disclosure of their accounts, which they say makes it difficult to assess their cashflow.
“SMEs shouldn’t just cry because they can’t get a loan from us,” said one Chinese bank executive. “They should first have clear financial statements and improve the disclosure of their balance sheets.”
However, the underground lenders “are not reckless”, according to Liu, who has spoken to some of them. “They do look at borrowers’ assets and their ability to pay back.”
Indeed, the higher interest rates they charge are somewhat understandable given the added investment needed to get a clear picture of the borrowers’ status, according to Liu.
Even so, she said private lenders need to be regulated to provide stability and transparency to their business processes. To further reduce risk, private lenders should stay local and avoid the dangers of expansion. “You know well which one of your neighbours is able to pay off debt.”
